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Why Markets should not Necessarily Reduce the Tick Size

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					             Centre de Recherche en Gestion




Why Markets should not Necessarily Reduce the Tick Size

              David Bourghelle and Fany Declerck


                         October 2002




               Cahier de recherche no. 2002 – 155




            IAE de Toulouse
            Place Anatole France – 31042 To ulouse Cedex
            Tél : 05 62 30 34 21 – Fax : 05 61 23 84 33
            E- mail : nicole.cassagne@univ-tlse1.fr
       Why Markets should not Necessarily Reduce the Tick Size

                              David Bourghellea and Fany Declerckb, c∗
                                           a
                                               IAE, Lille 1 University
                                               b
                                                 Toulouse University



                                                 October 2002



Abstract

This paper studies the consequences of a tick size change thus providing a natural experiment
on the computerized limit-order trading system (Euronext Paris). The change raised the tick
size for some stocks and lowered it for other. The results show that reductions (increases) in
tick size are associated with reductions (increases) in quoted depth and less (more) order
exposure. Limit order submissions inside the spread increased (decreased) with a reduction
(increase) in the tick size. However, in contrast with US exchanges results, this generated
neither a reduction in liquidity provision for large trades nor a change in the spread. This last
result implies an increasing but convex relationship between the relative tick size and the
relative bid-ask spread. Thus, it appears that a new pricing grid does not necessarily lead to
change execut ion costs but it changes the level of transparency in the liquidity supply.

JEL Classification: G14 – G18 – G19

Key words: tick size, liquidity supply, spread, market depth and order exposure.




   c
     Correspondance: Fany Declerck – Université de Toulouse 1 – Manufacture des Tabacs – MF 308 – 21 allée
de Brienne – 31000 Toulouse; Voice: +33.(0)561-128-570; Fax: +33.(0)561-225-563; Email:
fany.declerck@univ-tlse1.fr
   We are indebted to Bruno Biais and Richard Roll for very insightful discussions, suggestions and advice. We
thank P. Alphonse, C. Bisière, E. De Bodt, M. Demarchi, R. De Winne, A. François -Heude, R. Gillet, P. Hazart,
R. Van Ness, seminar participants at the IDEI (Fourth Toulouse Finance Workshop), the PASFI (Lille Business
School Workshop) and the AFFI and NFA meetings for valuable comments and suggestions. We are grateful to
Euronext -Paris for providing data. All remaining errors are our own.
1. Introduction

       Competitive pressure recently led US and Canadian exchanges to carry out large

decreases in the tick size. This price increment between two consecutive prices determines the

minimum quoted bid-ask spread, which is important in determining transaction costs.

Following the sixteenths and the decimalizatio n programs, US average execution costs

decreased significantly from 38.10 in September, 1996 to 24.55 basis points in December,

2000.1 Venkataraman (2001) also find that execution costs are higher in Paris after the

reduction on the NYSE. On January 4, 1999, Euronext Paris adopted a new pricing grid

intended to reduce execution costs and improve market quality.

       There is a significant debate among academics, regulators and practitioners about the

optimal tick size. From a theoretical point of view, Cordella and Foucault (1999) establish

that a zero tick size does not minimize trading costs. Moreover when the tick size is large,

traders are more willing to quote the competitive spread. A coarse pricing grid enforces time

priority and protects limit orders from adverse selection [Harris (1991) and Seppi (1997)].

However since the tick size is the lower bound of the bid-ask spread, Harris (1994) predicts

that a reduction in the tick size would decrease the quoted spread. Nevertheless, the reduction

in the spread could also decrease order exposure because liquidity provision is less profitable

and more risky. As a consequence, the quoted depth would also decline. 2

       In 1994 the Hong Kong Stock Exchange reduced the tick size by 50%. After a four-

month evaluation program and a large drop in trading activity, the computerized limit order

market reverts to the original tick size for the low priced stocks. Besides, a few weeks only

   1
       Source: Elkins/McSherry quarterly statistics.
   2
       Harris (1994) estimated a cross-sectional discrete model to assess the impact of a reduction in tick size. He

projected that quoting in sixteenths would result in a decrease in spreads (quoted depth) of 38% (16%) for stocks

with price under $10. He also predicted an increase in daily volume of 34% for these stocks.



                                                          1
after the decimalization program on the NYSE, some institutional traders strongly requested

an increase of the minimum tick size from one to five cents. This suggests the potential

advantages of a coarser pricing grid.

       Numerous papers have empirically investigated the consequences of reduction in tick size

on market quality. 3 As mentioned in Harris (1991, 1994), Seppi (1997), Chordia et al. (2001)

and Biais et al. (2001), a tightening of a pricing grid would generally result in a reduction in

the bid-ask spread. While the change in tick size improves the liquidity for small size orders,

Goldstein and Kavajecz (2000) and Lipson and Jones (2001) find that institutional traders are

worse off. They have to bear an increase in trading costs following the decline in depth

throughout the entire order book.

       The net effect of tick size changes on execution costs and liquidity supply may depend on

market design. For example, the ability to undercut on a fine grid may be especially profitable

for floor traders and specialist on the NYSE. The privileged information set of the specialist

and the floor traders is such that they can take advantage of undercutting the best quotes.

Consequently investors away from the floor have to face with a winners' curse. While

empirical papers cited above consider the effects of the tick size change on specialists or

dealers markets, the present paper studies the consequences in an electronic limit order

market. With this market structure, fully displaying limit orders provides free trading options

to quote matchers who can trade in front of large traders. Yet, a tighter pricing grid may not

adversely affect the cumulated depth in a central limit order book if the liquidity providers can

partially hide their orders and/or if traders shift their limit orders to prices further from the

quotes. Inversely, even if a coarser pricing grid could result in a larger cost of immediacy, it

may increase propensities of traders to expose their orders, thus balancing the cost effect and

improving market liquidity.


   3
       See Harris (1997) and Van Ness et al. (1999) for an extensive review of these studies.



                                                         2
       The new price schedule at Euronext Paris offers an opportunity to explore theses two

issues simultaneously. Before the switch, although the relative tick size for stocks over

2,000FRF (French Franc) was only 0.05%, it reached 0.20% for stock price just over 500FRF.

The new pricing grid was designed so that the relative price increment did not exceed 0.10%

of share prices. Consequently the rule changes lowered the tick size for some stocks (what we

call “DTS” or decreasing tick size sample) and increased it for other (“ITS” or increasing tick

size sample). Thus, we can both examine the relaxation and the tightening of the tick size

constraint. Our main results are the following.

       In marked contrast with previous studies, we do not observe any significant change in the

relative quoted and effective spreads for both decreasing and increasing tick size sub-

samples. 4 Two reasons explain this result. Firstly, the old pricing grid probably did not cause

artificially wide spreads. Thus, the proportion of one tick spreads is only about 10% prior to

the tick size reduction. Secondly, while the average relative tick size went from 0.1062% to

0.0578%, the average spread to tick ratio (the average number of ticks observed in the average

quoted spread) rose from 4.72 to 7.89. Thus, a reduction in tick size does not necessarily lead

to reduced execution costs, which suggests an increasing but convex relationship between the

relative tick size and the relative spread.

       Furthermore, we show evidence of a significant decrease in the relative spread for cross-

listed stocks on the NYSE during common trading sessions. Nevertheless, trading volume did

not move from the NYSE to Paris. This provides evidence of a cost-based competition

between US and Europe.




   4
       Even if the relative ticks were rather different among stocks before the change over to sixteenths on the

NYSE, AMEX or NASDAQ, all US studies showed a significant decrease in proportional quoted spreads after

the change.



                                                        3
    Results on quoted depth at the best quotes and order submission are consistent with prior

studies. Investors use more (less) hidden quantity orders with a reduction (increase) in the tick

size. Moreover, limit order submission inside the spread increase (decrease) with a reduction

(increase) in the tick size. So decreases (increases) in tick size are associated with reductions

(increases) in quoted depth. Finally there is a significant increase in the average proportion of

trades for which the quoted depth at the best quotes is not as sizeable enough to allow

complete execution of orders. Nevertheless, the volume weighted average spread is

unchanged, revealing that institutional large traders do not suffer from the switch. Due to a

smaller relative tick size traders can obtain priority at less cost; we clearly observe a change in

the traders’ behavior to protect themselves from front-running strategies.

    This paper is organized as follows. The next section discusses the hypothesis tested in

this paper. Section 3 describes the trading system and presents data used in the paper. Section

4 provides our empirical results. Some concluding remarks are contained in section 5.

2. Empirical hypothesis

    The minimum price increment is a determinant of the bid-ask spread, liquidity, order

exposure and depth. The economic insights which provide the background of our

investigation are the following.

2.1. Bid-ask spread and international competition

    The tick size affects the quoted bid-ask spread. Without a constraint, competitive

liquidity supply induces a bid-ask spread based on trading volume, risk and information. If the

price increment is larger than the competitive spread, a reduction in the tick size would lead to

a reduction in the cost of immediacy thus encouraging trading [Harris (1994)]. On the

contrary, a raise in trading costs should follow tick size increases.




                                                4
       Testable hypothesis 1 : If the current tick size is a binding constraint, a tick size reduction

could lower the quoted bid-ask spread, otherwise it would have no impact. On the other hand,

an increase in trading costs should follow tick size increases.

       A change in execution cost could also affect competition for order flow for cross-listed

stocks. The main motive for a firm to cross- list shares on both domestic and foreign markets

is to get a significant increase in the trading volume of the stock and to promote market

liquid ity. Nevertheless, the consequences of dual listing on liquidity and trade costs are

unclear (Foerster and Karolyi, 1996 and 1998, Domowitz et al., 1998). Foerster and Karolyi

(1993) predict that dual listing and a decrease in the price increment can increase competition

for order flow and reduce the bid-ask spread in the home market. It can also lead to a

migration of the order flow towards the foreign market, worsening home stock liquidity.

Consequently for cross- listed stocks, We study the impact of tick size change on trade costs

and competition for order flow on both Paris and New York

       Testable hypothesis 2 : If trading costs for some stocks both listed on the NYSE and the

Paris Bourse are lower after the switch in Paris, investors should prefer to trade in Paris rather

than on the NYSE. So, a change in execution costs should intensify cost-based competition

and draw market share away from the most expensive market.

2.2.     Liquidity supply and order exposure

       If time priority is enforced, traders have to improve the best quote to jump ahead of the

book. Harris (1996) and Angel (1997) demonstrate that with a finer pricing grid, the cost of

acquiring order precedence through price priority is marginal. So time priority protects limit

orders against quote- matching and front-running. This competition takes place when traders

submit limit orders inside the spread. Therefore a smaller tick size allows traders to obtain

priority at a lower cost.




                                                   5
       Testable hypothesis 3 : For a given spread, the number of orders submitted inside the

spread would increase (decrease) after a tick size reduction (increase).

       A reduction in the minimum price increment facilitates undercutting and quote- matching

behavior. To cut down order exposure, investors can split their orders into several small

orders, cancel and/or modify their orders more often, or finally use more frequently hidden

quantities when the tick size decreases. 5

       Testable hypothesis 4 : Traders will reduce their order exposure after a tick size

reduction. Conversely, order exposure will increase after an increase in tick size.

2.3. Quoted and cumulated market depth

       If the tick size is a binding constraint on the spread, the latter is artificially inflated and it

is profitable to submit limit orders in the book. While a smaller tick size may narrow quoted

bid-ask spread, it could adversely affect liquidity provision. The difference between the sell

and buy prices represents the revenue per share for providing immediacy to market orders.

Thus, as liquidity supply is less profitable after a tick size reduction, smaller sizes could be

offered at the best quotes.

       Testable hypothesis 5: A smaller (larger) tick size would decrease (increase) quoted

depth at the best quotes.

       As noted in Lau and McInish (1995) and Goldstein and Kavajecz (2000), a reduction in

tick size could lead liquidity providers to reduce depth not only at the best prices but away

from the best quotes too. As a consequence, it is important to check if large liquidity

demanders are not worse off by suffering from an increase in transaction costs. For instance

on the NYSE, Jones and Lipson (2000) find that institutional trading costs increase with the

   5
       Euronext Paris allows traders to display only a portion of their orders. The remaining size is hidden.

Harris (1997) finds that the proportion of hidden orders is larger for stocks trading with a fine tick size in Paris.




                                                          6
change to sixteenths, as the depth decreases throughout the entire order book. The net effect

of a tick size change on the cumulative depth and the cost of trading large order sizes is hence

unclear. The cumulative depth at a given price could remain constant if liquidity providers

shift their limit orders further from the best quotes. Moreover, for the stocks that experienced

an increase in the relative tick size, a change in cumulated depth could be observed if

investors expose more orders.

    Testable hypothesis 6: A smaller tick size does not make larger-sized orders more

expensive.

3. Trading system and data

3.1. Market design

    This study investigates the impact of the tick size changes at Euronext Paris, which is

based on a computerized limit-order trading system. Orders are prioritized for execution in

terms of price and time: orders for each security are ranked by price limit as they enter the

system. For example, buy orders specifying a higher limit are executed before orders with

lower limits. Secondly, orders are ranked in chronological order: two buy or sell orders at the

same price will be executed in the order in which they arrive on the central book. There is no

designated market maker who has the obligation to provide liquidity. A limit order trader

provides to other investors the ability to execute against his limit order. So, limit orders

provide liquidity to those who demand immediacy (market order traders).

    The trading day is ten hours, beginning at 7:15 a.m. and ending at 5:30 p.m. Paris local

time. From 7:15 a.m. to 9:00 a.m., the market is in pre-opening phase and orders are fed into

the centralized order book without being executed. The market opens at 9:00 a.m. The central

computer automatically calculates the opening price or call auction price at which the largest

quantities can be traded. From 9:00 a.m. to 5:25 p.m., trading takes place on a continuous

basis. The arrival of a new order immediately triggers one or several trades if matching orders


                                               7
exist on the other side of the book. From 5:25 p.m. to 5:30 p.m., the market is in its pre-

closing period. As in the pre-opening session, orders are fed into the order book. The market

closes at 5:30 p.m. with a call auction that determines the closing price. Trading is

anonymous. Cancellation of orders may be done at any time.

       Starting on January 4, 1999, the new pricing grid sets a sliding scale of tick size. The tick

size varies from €0.01 for prices up to €50, €0.05 for prices between €50.05 and €100, €0.10

for prices between €100.10 and €500, and €0.50 for prices above €500.

       Euronext introduced rules on block trading to allow immediate and full execution at a

price derived from quotes available on the central market. Block trades have to be filled at the

weighted average spread. The weighted average bid-ask spread (WAS) represents the price

for blocks of one time the Normal Market Size (NMS). It is calculated in real time for a given

quantity of shares by computing the average of bid and ask quotes weighted by the number of

shares displayed at the successive bids and asks.

3.2. Data

       The stock sample consists of 232 stocks traded in the continuous market with at least 5

trades per day. 6 The component stocks are the most actively traded and provide a reasonable

representation of the market. They account for about 90% of the market capitalization, and

about 98% of the market volume. Finally, we do not observe any economic sector’s

concentration for increase or decrease tick size sub-samples (table 1). We use the Euronext

intra-day best quotes, orders and transaction prices about all stocks for each day. Information

is time-stamped to the second. Call auction opening and closing prices are such that traders

who submit orders may use different strategies than those who submit to the continuous

market. To account for abnormal trading patterns and procedures around the start and the

   6
       As stock splits affect liquidity and order placement strategies (Easley et al., 2001), we exclude 3 stocks with

splitted share.



                                                          8
close of the trading day, the opening and closing call auctions are excluded. As for the sample

period, the continuous trading session begins at 10:00 a.m. and ends at 5:05 p.m., we

therefore examine only trades and quotes between 10:00 a.m. and 5:00 p.m..

       The examination period extends from 48 trading days (October 16, 1998) prior to the

switch through 30 trading days (March 12, 1999) after the switch. We exclude 5 trading days

before the change to eliminate any unusual trading behavior associated with the end of the

year. We also exclude the January data to eliminate the January-related seasonality. We call

the 48 trading days preceding the window the pre-event period and the 30 trading days

following the window the post-event period. 7 There are 3 215 859 trades, 10 832 753 orders,

and 1 077 646 cancellations of orders in the sample.

       The tick size can dynamically change with the price level when a given stock passed

through a price bound which makes it trade with a different tick for a short while (for example

if the stock price is around €50). To check the impact of this mechanism, we perform the

statistics without these stocks. We obtain the same results.

3.3. Trading activity

       The first half of 1999 at Euronext Paris followed the same trend as 1998’s exceptional

figures, once again beating a succession of records as the CAC40 index rose above the 4,600-

point mark for the first time; an increase of 15% for the first six month of 1999. Transaction

volumes reached €323.46 billion, a 26.51% progression from 1998’s first half, which had then

set a record. The total number of trades from January to June was 25.96 million – an increase

of 17.5%.




   7
       As some organizational and regulatory changes occurred in 1998 and 1999 at Euronext Paris (changes in

opening hours, adoption of a fixing procedure for the market closing), we cannot compare January, 1998 (pre-

event period) with January, 1999 (post-event period).



                                                        9
       The daily average of €2.6 billion in transaction volumes also sets a record, representing a

22.9% increase compared to the first six months in 1998. Total transaction volume for the

first eight months was €437.46 billion, a 30% increase over the same period in 1998, with

34.9 million trades being registered (+22.6%). On the whole year, the CAC 40 index

increased by 48.7%, the second largest increase since 1987.

       Summary statistics for the sample firms are shown in table 2. The equally- weighted

statistics are obtained by calculating the average by firm on all the trading days, and then by

calculating the average over firms. The summary statistics are measured over the post-event

period. The stocks are divided into four sub-samples based upon stock index classification. 8

                                          PLEASE INSERT TABLE 2 HERE

       Average market capitalization is €3 billion with a maximum of €84 billion, which is

13,556 times the minimum. The price range is large: the minimum is €0.06 and the maximum

is €859, with an average €94, which is higher than US average price (Jones and Lipson,

2000). Average daily volume is about €7 million per stock, with a minimum (maximum) of

€6 (113,908) thousand. Trading volume for a time interval can be divided into two

components, the number of trades and the average trade size. It appears that the daily € trade

size increases with trading activity: €8,971 for stocks which are not included in an index and

€41,187 for CAC 40 stocks. 9




   8
       The stock index classification indicates if the security is a component of the CAC 40 index or a CAC 40

substitute stock (the most liquid stocks), a component of the SBF 120 index but not of the CAC 40 (80 stocks), a

component of the SBF 250 index but not of the SBF 120 (the less liquid stocks) or if the stock is not a

component of any of the three indexes.
   9
       As informed investors want to maximize the profit they can obtain from their private information, they may

hide their trading activity by splitting one large trade into several small-sized trades [Kyle (1985) and Admati

and Pfleiderer (1988)]. Jones et al. (1994b) investigate how daily price volatility could be exp lained by the daily



                                                        10
     The average bid-ask spread is €0.89 and the average percentage spread is around 1.33 %

for all stocks against 0.43% for CAC 40 stocks. Angel (1997) reports that the median

percentage spread is 0.32% for the Dow Jones Industrial Average index stocks. Venkataraman

(2001) finds that in 1997 the quoted spread in Paris is lower than spread on similar NYSE

stocks when the tick size at the NYSE is an eighth. However the spread on the Paris bourse is

higher than the NYSE spread after the switch to the sixteenth. Bid and ask depth at the best

quotes measure the number of shares that can be sold or bought with any price movement. As

expected, the percentage spread decreases and the quoted depth increases as one moves to

more liquid stocks.

4. Empirical results

4.1. The new pricing grid and the relative tick size

     Table 3 shows details related to the pricing grid around the switch. It indicates the

number of stocks for each tick size and the maximum relative tick size (the ratio of the price

increment to the minimum share price). The maximum relative price increment was for a

stock priced at 5.05 FRF before the switch (1%), but it never exceeds 0.10% with the new

pricing grid.

                                          PLEASE INSERT TABLE 3 HERE

     The last column (panel A) shows that before January 4, 1999 about 90% of the stocks

were quoted with a tick size of 0.1 FRF or 1 FRF. After the switch, this clustering effect is not

observed any more (panel B). The tick size cons traint is more likely to be binding at the inside

quotes for liquid and/or low priced stocks. Indeed, given a large relative tick size the

proportion of one-tick spreads (bid-ask spread equals to the price increment) should be high.



number of trades and the average trade size. They find that the number of trades appears to provide more

explanation for the volatility-volume relation than the average trade size.



                                                        11
    Tables 4 and 5 indicate that we can separate 148 stocks with a decreasing tick size from

84 other stocks bearing an increase in the relative price increment after the switch (significant

at 1%). For the former (“DTS” stocks), the proportion of one-tick spreads remained stable or

decreased dramatically, and as expected the quoted depth generally decreased. For the latter

(“ITS” stocks), the larger relative price increment became binding (for example, the

proportion of one-tick spreads rose from 6.14% to 13.27% for stocks trading above €500),

suggesting important changes in market quality and liquidity provision.

                            PLEASE INSERT TABLE 4, TABLE 5 AND FIGURE 1 HERE

    Indeed, the switch provides a unique opportunity to investigate not only the effects of a

tick size reduction, but allows for separate examination of tick size increases. In the next

section, we begin by analyzing standard measures of bid-ask spreads.

4.2. Bid-ask spreads

        We compute the daily time weighted average proportional spread, i.e. the average of the

bid-ask spread to midpoint weighted by the proportion of the day that the spread was quoted.

Harris (1994) shows that the impact of the tick size reduction on liquidity is not uniform

across stocks because it depends on the trading activity. So, we partition the sample into four

sub-samples based on index classification. To test the hypotheses, we first calculate the time-

series averages in pre-event and post-event periods for each stock. Next we calculate the

cross-sectional means (or median for each sub-sample) and standard errors for each period. A

paired t-test for the full sample is performed to determine whether the change in the variable

is significant. As the sub-samples are small (between 17 and 48 stocks), we also performed a

non-parametric Wilcoxon test for each one 10 .




   10
        The same results were found when we used both parametric and non-parametric tests for the full sample.



                                                       12
     In accordance with theoretical and empirical analysis of tick size change, we anticipate a

decrease (increase) in both spread and depth following a decrease (increase) in relative price

increment (testable hypothesis 1).

                           PLEASE INSERT TABLE 6 AND FIGURE 2 PANEL A HERE

     In marked contrast to previous studies, we do not observe any significant decrease in the

time-weighted relative quoted spread for the decreasing tick size sample. This result suggests

that a reduction in tick size does not always lead to reduced transaction costs. Surprisingly,

the time-weighted proportional spread is not altered either by the tick size change for the

increasing tick size sample. The null hypothesis that the proportional spread is equal before

and after the switch for the ITS sample is not rejected at the 1% level. It suggests that the

increase in relative tick size did not lead to rising execution costs. Accordingly table 6 panel

A and B show that the time weighted relative spread and the relative effective spread are

unchanged for the two samples. The relative quoted spread remains on average at a 0.38%

level and the relative effective at a 0.19% level. 11

     How can we explain this odd result ? Firstly, the old pricing grid was finer than on the

other main stock exchanges. As observed in table 5, the average relative tick was 0.1062% for

the DTS and 0.0381% for the ITS. For the NYSE Jones and Lipson (2000) indicate that the

relative tick size is about 0.35% when the tick size is an eight, is about 0.18% when the tick

size is a sixteenth and is about 0.02% after the decimalization. Moreover Harris (1996)

indicates that the average value-weighted relative tick size is 0.09% in Paris in January and

February 1995 against 0.69% in Toronto during the November 8, 9, 14-18, 1994. He also


   11
        The paired t-test require cross-sectional independence. This might not be adequate here since our stocks

are affected by the same event. So, we estimate a time-series regression for each portfolio (sub-sample) with a

dummy variable (equal to zero in the pre-event period and one in the post-event period). This dummy is not

significant. This result implies that the new pricing grid did not lead to a change in the bid-ask spread.



                                                         13
indicates that the number of ticks in the average spread is 12.4 in Paris against 2.1 in Toronto.

Table 6 panel C presents statistics on the proportion of one-tick spreads for the four sub-

samples. It clearly appears that the constraint was not often binding in the pre-event period

(only 6.75% of spreads were equal to the price increment for the ITS sample and 9.94% for

the DTS sample). Therefore, the constraint of the tick size was far less binding on the Paris

stock exchange than on US exchanges. Therefore, the proportion of one-tick spreads rose

significantly to attain 14.33% after the switch for the ITS sample. It reveals more incentives

of some traders to be the first one to quote the narrowest possible spread, and “consequently

enjoy time priority at this relatively advantageous price”. 12 Conversely for the DTS sample,

the proportion of one-tick spreads decreased from 9.94% to a 5.10% level and the average

spread-to-tick ratio rose significantly. Liquidity providers were less prompted to be the first

one to quote the competitive spread.

    Secondly, our hypothesis was that a smaller price increment would have enhanced the

capacity of investors to improve quoted price because the old pricing grid was too coarse,

impeding competition and causing artificial wide spreads. Yet, Huson et al’s. (1997) analysis

of tick size decrease on the Toronto Stock Exchange should already have led us to expect no

change on spreads in the French case. Indeed, Huson et al. (1997) found a significant decrease

of the bid-ask spread only for shares with a price under $29.99 (the relative tick size drop

from 1.67% to 0.67%) but no significant change for shares with a price over $30 (the relative

tick size drop only from 0.30% to 0.13%). This result induces an increasing but convex

relationship between the relative tick size and the relative bid-ask spread, and is consistent

with the theoretical analysis of Cordella and Foucault (1999). They establish that the price

increment which minimizes the cost of immediacy and leads investors to post the competitive

spread is not zero.


   12
        Biais et al. (2001).



                                               14
4.3. International competition

    To test hypothesis 2 we consider two samples of stocks. The first one (CAC 40 sample) is

formed by 8 cross- listed stocks on the Paris Bourse and the NYSE (there traded as an

American Depositary Receipt). All these stocks are included in the CAC 40 index. They

exhibited a reduction of the relative tick size after the switch. The second sub-sample

(SBF 120 sample) is made up of the 8 other cross- listed stocks on both Paris and New York.

The latter consists of stocks not included in the CAC 40 index, and so not as frequently traded

as the former ones. They also exhibited a reduction of the relative tick size after the switch.

All trade and quote information are obtained from the TAQ database. American Depositary

Receipts are bank- issued negotiable certificates that give US investors ownership rights to

share in a foreign company. The depositary bank that holds the underlying securities in their

country of origin issues them.

                                   Please Insert Table 7 Here

    Table 7 presents changes in average trading volume and relative spread for both common

trading hours and the rest of the trading sessions. The primary finding is that order flows for

the cross- listed stocks do not migrate from US market to the Paris Bourse. Thus, no

significant change in average daily volume is observed even for common trading hours (panel

A). When the comparison is restricted to the common trading hours, table 7 panel B shows

that there is a significant 16% reduction in the relative spread quoted on NYSE from pre to

post switch (1.07% to 0.90%) for the CAC 40 stocks. However, there is no significant change

for the SBF 120 stocks. So US liquidity providers responded to the change in liquidity supply

in Paris by a reduction in trade costs for the NYSE cross- listed stocks for the most liquid

stocks. Nevertheless, as Huson et al. (1997) suggest, it seems that cross- listed order flow is

not sensitive to bid-ask spread alone.




                                              15
4.4. Liquidity supply and order exposure

    If time priority is enforced on a market, traders have to improve the best quote to jump

ahead of the book. With a finer pricing grid, the marginal cost of acquiring order precedence

through price priority is reduced. Therefore, a smaller (larger) tick size is likely to decrease

(increase) limit order submission on the best quotes (testable hypothesis 3). Moreover, time

priority protects limit orders against quote-matchers. A reduction in the minimum price

increment exposes limit orders traders to undercutting behavior. On the other hand, a rise in

relative tick allows investors to control for risk (testable hypothesis 4).

    As limit orders compete with market orders for order flow, changes in limit order activity

may be closely related to changes in market quality. In this section, we present some summary

statistics on the distribution of order flow across order types and order exposure. In Table 8

and 9, we sort on order types (market orders or limit orders), hidden quantity and order state.

We present the total daily order flow for each order type and also the proportion of each order

type relative to all orders. We test for changes in the daily number of orders and the daily

proportions. Table 8 is related to the decreasing tick size sample and table 9 to the increasing

tick size sample.

                             PLEASE INSERT TABLE 8 AND TABLE 9 HERE

    There are several noteworthy points here. First, whatever the sample, market orders

account for only 11% of orders while limit orders account for about 86% of orders. Secondly,

there was a significant change in the hidden quantity. The CAC system allows traders to

partially disclose their orders. For, a given price, precedence is given to displayed size over

hidden size. Indeed, this system hides the remaining size and displays it only after the

previous displayed size is executed. Harris (1994) argues that a reduction in the tick size

could lead to lower displayed depth, as liquidity providers hide more of their orders to avoid

quote matchers. Harris (1996) investigates the empirical relation between tick size and order



                                                16
exposure by using orders data from Euronext Paris and the Toronto Stock Exchange. He

shows that, unless price volatility is high, larger ticks are associated with greater order

exposure when the order is not expected to stand long.

    As we expected, hidden quantities as expressed as an average daily number of orders or

as a percentage of order volume increases significantly after the switch for the DTS sample.

In the same way, we observe a significant rise in the average daily portion of cancelled and

modified orders (table 8 panel D). This behavior suggests that investors want to hide more

often their trading interest.

    For the ITS sample, the use of hidden quantities, expressed both as a percent of all orders

and order volume, decreases significantly after the switch. As the tick size is now a binding

constraint for the bid-ask spread, costly undercutting practices are reduced and order exposure

becomes less risky.

    As a reduced (larger) relative tick size makes price priority less (more) costly, limit order

submission inside the best quotes is likely to increase (decrease). Table 10 shows clear

evidence of this behavior. The proportion of orders submitted inside the spread significantly

changes: +2.71% for the increase sub-sample and –3.73% for the decrease sub-sample. At the

same time, the daily average proportion of orders submitted at the best quotes significantly

decreases for the DTS sample from 14.83% to 12.17%. On the other hand, a larger relative

tick size encourages order exposure inside the book (+2.92%) rather than on the best quotes

(no significant change for the latter).

                                    PLEASE INSERT TABLE 10 HERE

    These results suggest an important change in the trading behavior of investors, especially

in terms of order aggressiveness. In fact, it provides empirical evidence that a finer pricing

grid reduces the willingness of limit order traders to provide market liquidity at the best

quotes.


                                              17
4.5. Quoted and aggregate depth

    As observed previously, a smaller tick size affects liquidity provision. Even if the relative

bid-ask spread is unchanged, less limit orders are offered at the best quotes after the switch

(table 4). We therefore calculate the € depth at the bid (ask) quotes, as the time weighted

average of the euro value of shares available for immediate trade (testable hypothesis 5).

Furthermore, the price at a certain aggregate quoted size could remain constant if liquidity

providers shift their limit orders to prices beyond the best quotes. Finally, it is important to

check if large liquidity demanders (institutional) are not worse off in suffering from an

increase in transaction costs for their large trades (testable hypothesis 6).

4.5.1   Quoted depth and the cost of trading small orders

    As indicated in table 11, and consistent with the empirical hypothesis, we find that the

quoted liquidity at the best quotes decreases significantly for the decreasing tick size sample.

For instance, across all firms, the average euro ask depth drops by one quarter and the average

euro bid depth declines from €84,439 to €76,175. The biggest change (-25%) occurs in firms

with high volume.

    Conversely, the quoted liquidity rises dramatically after the switch for the increasing tick

size sample (more than 30% increase for the entire sample). Even if traders submit only a

slightly more orders on the best quotes (not significant), they use less hidden quantities.

Consequently, traders are more willing to provide liquidity at the quotes after an increase in

the tick size. Probably because front-runners have to bear a considerable cost to get price

priority by improving quotes.

                       PLEASE INSERT TABLE 11 AND FIGURE 2 PANEL B HERE

    We also calculated the change in the average proportion of trades for which the quoted

depth was not as sizeable enough to allow complete execution at the best quotes (table 11

panel C). We find a large rise for the DTS stocks (from 27% to 30%) and no significant


                                                18
change for the ITS stocks. While this result may not necessarily indicate an increasing cost of

immediacy for the former, some buyers (sellers) have to walk up (down) the book to get

complete execution of their orders. 13

     To assess the tick size reduction impact on medium-sized orders execution costs, we

calculate a depth-to-trade size ratio around the switch. The depth-to-trade size ratio indicates

the number of times the average trade size is contained in the average quoted depth. As

observed in table 11 panel D, we document a large drop in the depth to trade size ratio

(- 56%) for the decreasing tick size sample, and no significant change for the increasing tick

size sample. It confirms that the reduction in tick size significantly restrains investors from

displaying trading interest at the quotes after a tick size reduction.

4.5.2     Cumulated depth and the cost of trading large orders

     As recognized by Harris (1994), a decrease in sizes at the best quotes does not indicate a

decrease in the total market depth. Yet, Goldstein and Kavajecz (2000) reconstruct the NYSE

limit order book around the tick size reform. For the 100 stocks they examine, depth decreases

throughout the book. Lau and McInish (1995) study the reduction in tick size from $0.50 to

$0.10 at the Singapore Stock Exchange. They find that the sum of all quoted sizes is reduced

after the tick size decrease. Jones and Lipson (2000) find that even if the cost of retail orders

declines after a tick size reduction, the cost of institutional orders is greater with a smaller tick

size. Seppi (1997) also predicts that a smaller tick size benefits to small traders but is costly

for large traders. In fact, the depth at the best quotes can not be considered as an adequate




   13
        Harris (1997) also shows that the tick size reduction results in a significant decrease in the quoted depth on

the Toronto Stock Exchange (as mentioned by Harris (1996), “the TSE uses a pure price-time order precedence

hierarchy to arrange trades” as does Euronext Paris).



                                                          19
measure of liquidity. Thus, Biais et al. (1995) show that for Euronext, “the provision of

liquidity at the quotes is only a small portion of the overall depth in the book”. 14

     This result can be reinforced by analysing potential changes in market conditions for

large (institutional) traders. Euronext introduced rules on block trading to allow immediate

and full execution of block trades at the Weighted Average Spread for a standard-size block

(WAS). This price is a volume weighted spread. Declerck (2000) shows that the quoted WAS,

which is calculated on 10 quotes on average, is 1.72%. At this price investors can trade 50

times the average trade size. Moreover, reserved (or “hidden”) orders represent up to 60% of

disclosed orders. It means that the disclosed market depth is much lower than the true market

depth. On average, the effective depth at the best limits is about three times higher than the

displayed depth. The effective volume weighted spread, which takes into account the hidden

quantities entered into the system, is only on average 0.80%.

                                        PLEASE INSERT TABLE 12 HERE

     Table 12 does not show evidence of any significant change in the WAS for the most

active stocks. They is only a slight increase from 3.11% to 3.40% for the SBF 120 index

stocks (significant at 10%). This result implies that institutional trading costs neither

increased nor decreased after the adoption of the new pricing grid. In marked contrast with

previous US studies, large traders did not suffer from damaging trading conditions

consecutive to a reduction (or a rise) in the relative tick size.

     To comp lete these results, we will have a look at the institutional behavior in response to

changes in tick size. Table 13 presents details related to block trades activity as a percentage

of the number of orders and the order volume.


   14
        Unfortunately, we were not able to make direct evidence of a potential change in the quantity of shares

posted at limit orders away from the quotes (cumulated depth) as the five best limits of the book are only

available after the switch.



                                                       20
                                  Please Insert Table 13 Here

    If there is no impact for the increasing tick size sub-sample, we can see that institutions

use less frequently block trades for the decreasing tick size sub-sample (-0.76%). As they

obtain a better protection in the central limit order book, they do not need to use the upstairs

market.

5. Conclusions

    This paper examines the impact of a tick size change in the Paris Bourse. Studying

consequences in bid-ask spread, order exposure and market depth, we deliver some insights

about the importance of the tick size for the "economics" of liquidity provision in an

electronic limit order book market. The change in the pricing grid allows us to examine the

effects of a tick size reduction, but gives us the opportunity for separate examination of tick

size increases.

    Results on quoted depth and order submission are consistent with prior studies. Investors

use more (less) hidden quantity orders, and limit order submission inside the spread increase

(decrease) with a reduction (increase) in the tick size. Reductions (increases) in tick size are

associated with reductions (increases) in quoted depth. Thus, a coarser grid makes

undercutting strategies more expensive and encourages investors to expose their orders.

Besides, by increasing the per-share rent, a larger relative tick makes liquidity supply more

profitable and probably attracts new limit order traders in the market. Thus, and in contrast

with previous US studies, institutional block traders do not suffer from damaging trading

conditions consecutive to a tick size decrease.

    Tick size reductions in US markets (dealer and specialist markets alike) are associated

with spread decreases. In marked contrast to US results, we do not observe any significant

change in the relative quoted and effective spreads for both decreasing and increasing tick

size sub-samples. This empirical evidence induces an increasing but convex relationship


                                                  21
between the relative tick size and the bid-ask spread. A reduction in tick size does not

necessarily lead to reduced execution costs but it changes the level of transparency in the

liquidity supply.

    To attract liquidity demanders, designers of trading systems have to encourage liquidity

provision and stimulate investors to fully display their orders. It appears that a relatively

coarse pricing grid does not always result in excessively large spreads, enhances quoted

depth, encourages liquidity providers to expose their trading interest and stimulate investors

to quote the competitive spread. Our analysis indicates that regulators may be well advised to

avoid reducing tick size if they want to attract liquidity providers, and if order exposure is

profitable for a market. Yet, the significant competition between trading mechanisms

highlights the need for future research related to the consequences of tick size on trading costs

and the dynamics of liquidity supply.




                                               22
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                                             26
Table 1
Sector classification of the sample firms

This table reports economic sectors statistics for the sample stocks around the adoption of the new pricing grid
on January 04, 1999. Percentages are beginning-of-year 1999 figures. Each percentage is the ratio of the number
of firms in each economic sector to the total number of firms.

                    Economic sectors                  Increase tick size          Decrease tick size
      Advertising                                          4.76%                       6.76%
      Aerospace and defense                                0.00%                       3.38%
      Agribusiness                                         2.38%                       4.05%
      Automotive equipment                                 3.57%                       6.08%
      Banking                                              4.76%                       4.05%
      Building materials                                   2.38%                       2.03%
      Chemicals                                            1.19%                       1.35%
      Conglomerate                                         2.38%                       5.41%
      Construction                                         1.19%                       3.38%
      Data processing and computer applications            1.19%                       6.76%
      Distribution, general consumer goods                 4.76%                       3.38%
      Distribution, specialty consumer goods               2.38%                       4.05%
      Electricity, electronics and telecom                 10.71%                      5.41%
      Entertainment and leisure                            1.19%                       1.35%
      Environment and public services                      2.38%                       6.08%
      Financial services                                   1.19%                       0.00%
      Food and beverage                                    2.38%                       3.38%
      Forest products and paper                            2.38%                       0.00%
      Heavy construction                                   2.38%                       2.03%
      Hotels, restaurants and tourism                      5.95%                       2.03%
      Industrial distribution                              1.19%                       2.03%
      Industrial transportation                            4.76%                       0.68%
      Insurance                                            7.14%                       2.03%
      Media and multimedia                                 0.00%                       0.68%
      Mining and metals                                    2.38%                       2.70%
      No sector                                            1.19%                       0.68%
      Nuclear energy                                       0.00%                       0.68%
      Oil                                                  2.38%                       2.03%
      Other household products                             0.00%                       2.03%
      Packaging                                            0.00%                       0.00%
      Pharmaceuticals and cosmetic                         4.76%                       3.38%
      Professional household products                      4.76%                       2.03%
      Real estate                                          2.38%                       4.05%
      Securities brokers                                   1.19%                       0.68%
      Specialty finance                                    3.57%                       2.70%
      Spectacle trade                                      0.00%                       1.35%
      Textiles and apparels                                4.76%                       1.35%




                                                      27
Table 2
Sample descriptive statistics


This table reports summary statistics for the sample stocks around the adoption of the new pricing grid on
January 04, 1999. The cross-sectional means are reported. Stock price and market capitalization are beginning-
of-year 1999 figures. Trading activity, quoted spread and depth measures are calculated from February to March,
1999 intra-day transactions and quotes data. All averages are equally-weighted means across firms. The intra-
day information is from the Euronext database. Stocks in the sample are partitioned into four sub-samples based
                                                                             uro
on index classification. The quoted spread is the difference between the e ask and euro bid quotes. The
proportional spread is the quoted spread in euros divided by the midpoint. Ask and bid depth are the number of
shares available at the best quote.



                                                                       Index
                        All firms         CAC 40           SBF 120           SBF 250             No index
                                                 Panel A: Firm Characteristics
Price (€)                94.52            151.07            99.84              86.14              39.83
Market cap
                         3,470             13,569            1,428               424               217
(million €)
                                                    Panel B: Trading Activity
Daily euro
                         7,505             32,088            1,888               276               197
volume in 1,000's
Daily No.
                          179               644                97                24                 33
of trades
Daily euro
                         18,554            41,187            17,537             10,009            8,971
trade size
                                                    Panel C: Spread and Depth

Quoted spread             0.89              0.56              0.92               1.18              0.74

Proportional
                         1.33%             0.43%             0.90%              1.52%             2.66%
quoted spread
Ask depth                23,027            55,796            22,212             10,096            8,486
Bid depth                21,908            52,023            19,627             11,572            8,276




                                                      28
Table 3
The pricing grid in the pre-event and post-event periods

This table presents details related to the pricing grid available and the number of stocks traded in each
                                                                       )
tick size category before (panel A) and after the switch (panel B on January 04, 1999. Maximum
relative tick size is the ratio of the price increment to the minimum share price for each category.
Minimum relative tick size is the ratio of the price increment to the maximum share price for each
category.



                                Maximum                         Minimum
                 Minimum                         Maximum                       Number of
                               relative tick                   relative tick                     %
                   price                           price                        Stocks
                                    size                            size
                                               Panel A: 1998 Price Increment
   0.01 F                                               5.00 F    0.20%             3         1.29%
0.05 F              5.05 F        1%                 100.00 F     0.05%            32         13.79%
   0.10 F         100.10 F        0.10%              500.00 F     0.02%           106         45.69%
   1.00 F         501.00 F        0.20%            5,000.00 F     0.02%            90         38.79%
 10.00 F        5,010.00 F        0.20%                                             1         0.43%
                                               Panel B: 1999 Price Increment
    0.01 €                                          50.00 €       0.02%           98          42.24%
    0.05 €         50.05 €        0.10%          100.00 €         0.05%           62          26.72%
    0.10 €        100.10 €        0.10%          500.00 €         0.02%           67          28.88%
    0.50 €        500.50 €        0.10%                                            5          2.16%

€ 1 = FRF 6.55957




                                                     29
Table 4
The new pricing grid and changes in the relative tick size


This table reports liquidity measures by price level for the sample stocks around the adoption of the new pricing grid on January 04, 1999. All averages are equally-
weighted means across firms. The intra-day information is from Euronext database. The proportion of one-tick spreads is the ratio of the number of one-tick spread
to the total number of quoted spread. The quoted depth is the euro number of shares available on the best bid and ask quotes. Results are based on standard
comparison t-test.



           Price range            Relative tick size           Proportion of one-tick spreads                            Quoted depth (€)
      1998             1999             1999              1998         1999             % change            1998           1999            % change
  ]100;197 FF]      ]15.25;30 €]     Decrease            8.83%        10.67%          1.83%                38,618         44,705        15.76%     ***
  ]197;328 FF]      ]30;50 €]        Decrease            2.46%        1.88%          -0.58%                54,589         56,336         3.20%     **
  ]328;500 FF]      ]50;76.25 €]     Increase            1.67%        7.06%           5.40%        ***     99,358        106,775         7.47%     ***
  ]500;656 FF]      ]76.25;100 €]    Decrease            18.20%       6.52%         -11.68%        ***     274,579       142,437       -48.13%     ***
  ]656;938 FF]      ]100;143 €]      Decrease            16.69%       9.96%          -6.73%        ***     209,764       190,118        -9.37%     ***
  ]938;1312 FF]     ]143;200 €]      Decrease            12.34%       9.19%          -3.15%        ***     146,361       127,103       -13.16%     ***
  ]1312;3280 FF] ]200;500 €]         Decrease            8.83%        4.16%          -4.67%        ***     163,461       148,004        -9.46%     ***
  > 3280 FF         > 500 €          Increase            6.14%        13.27%          7.13%        ***     123,862       206,362        66.61%     ***

€ 1 = FRF 6.55957

*** denotes significance at 1% level
** denotes significance at 5% level




                                                                                        30
Table 5
The new pricing grid, decreasing and increasing tick size samples

This table reports average measures of relative tick size around the adoption of the new pricing grid
on January 04, 1999. The rule changes raised the tick size for some stocks (ITS sample) and lowered
it for others (DTS sample).

                    All firms                    Index
                   Mean       CAC 40    SBF 120     SBF 250   No index
Before           0.1062%      0.1087%   0.0888%     0.1227%   0.0774%
After decrease   0.0578%      0.0585%   0.0506%     0.0677%   0.0555%
% change          -0.05% *** -0.05% *** -0.04% *** -0.05% *** -0.02% ***
N                    84          17        22          24        21

Before           0.0381%         0.0308%    0.0761%   0.0442%   0.1576%
After increase   0.0885%         0.0758%    0.1227%   0.0838%   0.6200%
% change          0.05%     **    0.04% *** 0.05% *** 0.04% ***  0.46%
N                   148             33         43        48        24

*** denotes significance at 1% level
** denotes significance at 5% level




                                                31
Table 6
Trading costs


This table provides data on spreads measures from the limit order book for the sample stocks during
periods from October to December, 1998 (pre-event period) and February to March, 1999 (post-event
period). The cross-sectional means and the average change between the two periods are reported. Statistics
are time-weighted for each firm and equally weighted across firms. Stocks in the sample are partitioned
into four sub-samples based on index classification. The proportional quoted spread is the quoted spread
divided by the midpoint. The effective relative spread is the absolute difference between the trade price and
the midpoint divided by the midpoint. The proportion of one-tick spreads is the ratio of the number of one-
tick spreads to the total number of spreads. Quoted spread to tick ratio is the average number of tick
included in the average euro bid-ask spread. Tests of significance are paired t-tests for the full sample and
the non-parametric Wilcoxon test for each sub-sample.


                      All firms                                        Index
                     Mean                CAC 40           SBF 120           SBF 250          No index
                                             Panel A: Quoted proportional spread
Before             0,3773%               0,2696%          0,7507%           1,1231%          1,0949%
After decrease     0,3846%               0,2669%          0,8306%           1,0999%          1,1086%
% change           0,0073%              -0,0027%          0,0799% *** -0,0231%               0,0137%

Before             0,3737%               0,2409%          0,7826%           1,4716%          2,3172%
After increase     0,3937%               0,2498%          0,7972%           1,6514%          2,6648%
% change           0,0201%               0,0089%          0,0146%           0,1798%     *    0,3476%
                                              Panel B: Effective proportional spread
Before              0,1903%              0,1368%          0,3564%           0,5828%          0,5526%
After decrease      0,1868%              0,1268%          0,4004%           0,5556%          0,5647%
% change           -0,0035%             -0,0100%          0,0440% *** -0,0273%               0,0121%

Before             0,1843%              0,1161%          0,4375%            0,6972%          1,0921%
After increase     0,2068%              0,1239%          0,5347%            0,8087%          1,1770%
% change           0,0225%              0,0078%          0,0972%            0,1115%    **    0,0849%
                                             Panel C: Proportion of one-tick spreads
Before               9,94%               28,41%           5,40%               4,74%            3,06%
After decrease       5,10%               14,26%           2,86%               2,29%            2,14%
% change            -4,84%        ***   -14,14% *** -2,54% ***               -2,46%    **     -0,92%    ***

Before              6,75%               11,20%           6,09%               2,36%            8,65%
After increase      14,33%              21,63%           9,81%               6,25%           21,67%
% change            7,58%         ***   10,43%    ***    3,72%     ***       3,89%     ***   13,02%      **
                                               Panel D: Quoted spread / tick size
Before               4,72                3,07             11,02              13,08            18,76
After decrease       7,89                5,32             18,20              20,07            28,16
% change            67,36%        ***   73,35%    *** 65,10% ***            53,49%     ***   50,11%      **

Before                12,33               8,82               25,37           45,02             32,00
After increase         5,21               3,54               10,74           22,46             16,22
% change            -57,71%       ***   -59,90%    ***     -57,65%   ***   -50,11%     ***   -49,32%     **

*** denotes significance at 1% level
** denotes significance at 5% level




                                                      32
Table 7
International competition

This table provides data on average trading volume and relatives spreads during periods from October to
December, 1998 (pre-event period) and February to March, 1999 (post-event period). The CAC 40 sample and
the SBF 120 sample are formed each by 8 cross-listed stocks at the Paris Bourse and the NYSE as an American
Depositary Receipt (ADR). The latter sample includes the less liquid stocks. All stocks exhibited a reduction of
their relative tick size after the switch. All trades and quotes information for ADR are obtained from the TAQ
database. The cross-sectional means and standard errors (in parentheses) are reported. The average change
between the two periods is also reported. Statistics are equally weighted across firms. Panel A lists results for the
daily volume expressed in 000’s US dollar terms, and panel B lists results for the average proportional quoted
spread (the quoted spread in US dollar divided by the midpoint). Tests of significance are paired t-tests.


                                                   1998                           1999
                                                                                                         % change
                                          Mean              Std          Mean            Std
                                                           Panel A: Daily dollar volume ('000$)
               Paris and NYSE open        2,524           (1,598)        2,508         (2,466)          -0.60%
   CAC 40
   sample          Only NYSE open         8,840           (7,073)        9,002         (7,932)           1.83%
                  All the trading day     11,361          (8,565)        11,510       (10,312)           1.31%

               Paris and NYSE open          92             (56)            82            (60)          -10.47%
  SBF 120
   sample          Only NYSE open          157            (112)           135            (92)          -13.86%
                  All the trading day      220            (147)           192           (143)          -12.73%
                                                                 Panel B: Relative spread
               Paris and NYSE open        1.07%           (0.36)         0.90%          (0.22)         -15,55%      **
   CAC 40
   sample          Only NYSE open         0.90%           (0.34)         0.81%          (0.22)          -9.62%
                  All the trading day     0.93%           (0.35)         0.82%          (0.22)         -11,48%          *

               Paris and NYSE open        8.68%           (8.83)        8.51%            (11.35)        -1.93%
  SBF 120
   sample          Only NYSE open         6.32%           (6.29)        6.55%             (7.40)         3.54%
                  All the trading day     6.90%           (6.96)        7.27%             (9.10)         5.40%

** denotes significance at 5% level
* denotes significance at 10% level




                                                          33
Table 8
The daily order submission across types - Decreasing tick size sub-sample


This table presents some statistics on the distribution of daily order submissions across order types and order
exposure related to the decreasing tick size sub-sample during periods October to December, 1998 (pre-event
period) and February to March, 1999 (post-event period). The cross-sectional means and the average change
between the two periods are reported. All averages are equally-weighted means across firms. The intra-day
information is from Euronext database. Stocks in the sample are partitioned into two sub-samples based on buy
or sell side. We compute the total daily order flow for each type of orders (market or limit order), hidden
quantity and order state and also as a proportion of total order submissions from intra-day orders. Tests of
significance are paired t-tests.



                                           Buys                                        Sells
                            Before       After        % change          Before      After        % change
                                                           Panel A: All orders
Number of orders            1098         1137        3.53%              1181        1211        2.58%
                                                        Panel B: Hidden quantity
Percent of all orders      14.62%       15.30%       0.69%     **      14.30%      15.34%       1.04%     ***
Percent of order volume    38.94%       41.59%       2.64%     ***     43.03%      45.02%       1.99%     ***
                                                          Panel C: Order type
Limit order                86.43%       87.06%       0.63%     ***     83.73%      85.16%        1.43%    ***
Market order               11.49%       11.00%      -0.48%     ***     12.86%      11.79%       -1.07%    ***
                                                          Panel D: Order state
Canceled                   10.68%       10.30%      -0.38%     **       9.76%      10.81%        1.05%    ***
Modified                   18.66%       18.70%       0.04%             16.32%      17.44%        1.12%    ***
Blank                      14.50%       15.34%       0.84%     ***     18.03%      20.28%        2.25%    ***
Filled                     55.81%       55.45%      -0.36%             55.30%      50.88%       -4.42%    ***



*** denotes significance at 1% level
** denotes significance at 5% level




                                                     34
Table 9
The daily order submission across types - Increasing tick size sub-sample


This table presents some summary statistics on the distribution of daily order submissions across order types and
order exposure related to the increasing tick size sub-sample during periods October to December, 1998 (pre-
event period) and February to March, 1999 (post-event period). The cross-sectional means and the average
change between the two periods are reported. All averages are equally-weighted means across firms. The intra-
day information is from Euronext database. Stocks in the sample are partitioned into two sub-samples based on
buy or sell side. We compute the total daily order flow for each type of orders (market or limit order), hidden
quantity and order state and also as a proportion of total order submissions from intra-day orders. Tests of
significance are paired t-tests.



                                             Buys                                        Sells
                            Before        After        % change          Before       After        % change
                                                            Panel A: All orders
Number of orders             1224         1401       14.48%     ***       2497        3151       26.19%      ***
                                                         Panel B: Hidden quantity
Percent of all orders       16.88%      14.09%       -2.79%     ***     13.34%       11.66%       -1.68%     ***
Percent of order volume     41.76%      40.58%       -1.18%      **     45.02%       41.48%       -3.55%     ***
                                                           Panel C: Order type
Limit order                 87.58%      87.67%        0.09%             81.96%       80.11%       -1.85%     ***
Market order                10.44%      10.27%       -0.17%             14.31%       15.53%        1.23%     **
                                                           Panel D: Order state
Canceled                    11.37%      11.10%       -0.27%      **      9.01%        9.45%        0.44%      *
Modified                    23.34%      18.64%       -4.70%     ***     16.07%       13.92%       -2.15%     ***
Blank                       13.88%      15.46%        1.58%     ***     19.88%       21.65%        1.77%     ***
Filled                      50.85%      54.39%        3.54%     ***     54.37%       53.92%       -0.45%



*** denotes significance at 1% level
** denotes significance at 5% level




                                                      35
Table 10
Order aggressiveness


This table provides data on order aggressiveness for the sample stocks during periods October to
December, 1998 (pre-event period) and February to March, 1999 (post-event period). Proportions on each
class are reported. The average change between the two periods is also reported. The designation in the
book means that the order is submitted at a lesser price than the best price on the book. On the best quote
means that the order is submitted at a price equal to the best price. Inside the spread means that the order is
submitted at a greater price than the best price. And finally, marketable limit order denotes that the limit
order will be immediately executed at the best bid price for a sell order and at the best ask price for a buy
order. Statistics are time-weighted for each firm and equally weighted across firms.

                         Decreasing tick size sub-sample               Increasing tick size sub-sample
                       1998       1999           % change           1998         1999           % change
                                                      Panel A: All firms
Marketable orders     28.38%     26.73%        -1.65%     **       26.56%       26.88%         0.32%
Inside the spread     12.85%     15.56%         2.71%    ***       16.02%       12.29%        -3.73% ***
On the best quote     14.83%     12.17%        -2.66% ***          11.46%       11.95%         0.49%
In the book           43.94%     45.55%         1.60%     **       45.96%       48.88%         2.92%   ***
                                                      Panel B: CAC 40
Marketable orders     29.50%     27.79%        -1.71%     **       27.31%       27.75%         0.44%
Inside the spread     11.80%     15.25%         3.46%    ***       16.43%       12.39%        -4.04% ***
On the best quote     15.74%     12.22%        -3.52% ***          11.08%       11.60%         0.52%
In the book           42.96%     44.74%         1.77%     **       45.18%       48.26%         3.08%   ***
                                                      Panel C: SBF 120
Marketable orders     25.14%     22.86%        -2.28% ***          24.56%       24.28%        -0.28%
Inside the spread     15.75%     16.44%         0.69%     *        14.09%       10.64%        -3.45% ***
On the best quote     13.15%     12.63%        -0.51%     *        12.69%       13.24%         0.55%
In the book           45.97%     48.07%         2.10%     **       48.66%       51.84%         3.17%   ***
                                                      Panel D: SBF 250
Marketable orders     26.11%     23.97%        -2.14%     **       24.64%       24.46%        -0.17%
Inside the spread     17.36%     17.49%         0.13%              17.94%       16.57%        -1.37%    **
On the best quote     12.01%     11.17%        -0.84%              11.72%       10.87%        -0.85%
In the book           44.52%     47.38%         2.85%     **       45.70%       48.09%         2.39%    **
                                                      Panel E: No index
Marketable orders     26.52%     25.71%        -0.82%              27.24%       26.82%        -0.42%
Inside the spread     11.80%     14.94%         3.14%    ***       17.69%       14.61%        -3.08% ***
On the best quote     10.71%     10.17%        -0.53%              10.80%       12.92%         2.12%    **
In the book           50.97%     49.18%        -1.79%     *        44.27%       45.65%         1.38%     *



*** denotes significance at 1% level
** denotes significance at 5% level
* denotes significance at 10% level




                                                      36
Table 11
The quoted depth

This table provides data on liquidity measures from the limit order book for the sample stocks during periods
October to December, 1998 (pre-event period) and February to March, 1999 (post-event period). The cross-
sectional means and the average change between the two periods are reported. Statistics are time-weighted for
each firm and equally weighted across firms. Stocks in the sample are partitioned into four sub-samples based on
index classification. Average depth is the euro number of shares available on the best quotes. Tests of
significance are paired t-tests for the full sample and the non-parametric Wilcoxon test for each sub-sample.



                         All firms                                        Index
                        Mean                 CAC 40           SBF 120           SBF 250           No index
                                                   Panel A: Average of Euro Ask Depth
Before                87,185.85            101,658.48         25,115.19        18,166.66          9,839.18
After decrease        65,112.45             74,625.31         25,494.40        18,181.16          8,018.12
% change               -25.32%       ***    -26.59%     ***     1.51%            0.08%            -18.51%     **

Before                51,092.28            57,010.10         24,977.63         10,953.57          10,881.75
After increase        72,167.12            81,211.52         32,596.37         8,949.41           13,183.92
% change               41.25%        ***    42.45%     ***    30.50%            -18.30%     **     21.16%     **
                                                  Panel B: Average of Euro Bid Depth
Before                84,439.95            97,489.80         17,001.83         40,733.26          12,959.85
After decrease        76,175.21            72,840.09         17,369.51         22,266.99          11,038.05
% change               -9.79%              -25.28%     ***     2.16%            -45.33%     ***    -14.83%

Before                55,876.85            62,894.52        23,855.13         9,583.33            14,015.72
After increase        73,868.93            83,703.02        27,779.64        12,249.99            16,682.24
% change               32.20%        ***    33.08%   ***     16.45%     *     27.83%        **     19.03%      *
                                                   Panel C: Not enough depth (%)
Before                 27.38%               23.70%           28.65%           29.56%               25.82%
After decrease         30.61%               29.20%           31.05%           30.89%               31.23%
% change                3.23%        ***    5.50%    ***      2.40%    ***     1.33%                5.42%     ***

Before                 26.91%               28.51%             28.84%              29.60%          21.07%
After increase         27.38%               26.42%             28.29%              30.11%          24.37%
% change                0.47%               -2.09%       **    -0.55%               0.51%           3.29%
                                                       Panel D: Depth to trade size
Before                   38.91                45.47              8.69                7.12           23.87
After decrease           17.11                19.04              8.07                6.37           18.14
% change               -56.02%       ***    -58.13%     ***    -7.05%       *     -10.57%         -23.98%     ***

Before                  35.38                40.01              9.70              6.96              27.57
After increase          34.95                39.58             10.09              5.39              22.86
% change               -1.23%               -1.07%             4.02%            -22.50%      *    -17.10%      *



*** denotes significance at 1% level
** denotes significance at 5% level
* denotes significance at 10% level




                                                       37
Table 12
Institutional block trading and volume weighted bid-ask spread


This table analyzes changes in the weighted average bid-ask spread for the CAC 40 and SBF 120 stocks during
periods October to December, 1998 (pre -event period) and February to March 08, 1999 (post-event period)15 .
The cross-sectional means and the average change between the two periods are reported. All averages are time-
weighted for each firm and equally weighted across firms. The intra-day information is from Euronext database.
The Weighted Average Bid-Ask Spread (WAS) represents the price for blocks that exceed to the Normal
Market Size (NMS). Euronext calculates the WAS for a given quantity of shares in real time by taking the
average of bid and ask prices for all orders placed in the central order book, weighted by the number of shares
displayed at the successive bids and asks. Tests of significance are paired t-tests.


                                                                       Index
                                        All firms            CAC 40             SBF 120
                     Before             2.37%                1.90%             3.11%
                     After decrease     2.52%                1.95%             3.40%
                     % change           0.15%       *        0.06%             0.29%      *
                     N                    52                   31                20

                     Before             2.33%                2.20%             2.53%
                     After increase     2.43%                2.31%             2.63%
                     % change           0.10%                0.10%             0.10%
                     N                    28                   16                10

*   denotes significance at 10% level




    15
         We cannot take into account data after March 08, 1999 because some stocks experienced a NMS change.



                                                        38
Table 13
Institutional block trading behavior


This table analyzes changes in the use of block trades for the sample stocks during periods October to
December, 1998 (pre-event period) and February to March, 1999 (post-event period). The cross-sectional means
and the average change between the two periods are reported. All averages are equally weighted across firms.
The intra-day information is from Euronext database. Tests of significance are paired t-tests.

                                   Increasing tick size                      Decreasing tick size
                            Before      After         % change       Before      After         % change
                                                          Panel A: All firms
Percent of order volume     7.05%      6.29%         -0.76%    **     7.35%      7.38%         0.03%
                                                           Panel B: CAC 40
Percent of order volume     6.99%      5.95%         -1.04%    **     7.18%      6.83%        -0.35%
                                                          Panel C: SBF 120
Percent of order volume     5.48%      6.42%          0.95%           7.48%      8.41%         0.93%    **
                                                          Panel D: SBF 250
Percent of order volume     12.43%     10.99%        -1.44%           9.96%     14.35%         4.39%
                                                          Panel E: No index
Percent of order volume     9.39%      14.01%         4.62%           8.76%      9.73%         0.97%

*** denotes significance at 1% level
** denotes significance at 5% level




                                                    39
Figure 1
Changes in the relative tick size by price range

These figures report measures by price level for the sample stocks around the adoption of the new pricing grid
on January 04, 1999. We observe an increase in the relative tick size for prices between €50 and €76.25 and for
prices above €500. We observe a decrease in the relative tick size for all other price ranges.


                                                      Proportion of one-tick spread

                70%


                60%

                50%


                40%


                30%


                20%

                10%


                0%
                      ]15.25;30 €]   ]30;50 €]   ]50;76.25 €] ]76.25;100 ]100;143 €] ]143;200 €] ]200;500 €]       > 500 €
                                                                   €]

                 1998            1999                              Price range




                                                              Quoted depth (€)

                300,000


                250,000


                200,000
   €uro depth




                150,000


                100,000


                 50,000


                      0
                          ]15.25;30 €]   ]30;50 €]   ]50;76.25 €] ]76.25;100 ]100;143 €] ]143;200 €] ]200;500 €]     > 500 €
                                                                      €]
           1998           1999                                        Price range




                                                                    40
Figure 2
Trading costs by volume quartile

This table provides data on liquidity measures from the limit order book for the sample stocks during periods October to December, 1998 (pre -event period) and February to March,
1999 (post-event period).

Panel A: the relative spread and the proportion of one tick spread




                                                                                       41
Panel B: euro ask and bid depth on the best quotes




                                                     42

				
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